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This CESifo group Munich seminar
took place on June 11, 2018 in Ludwig-Maximilian University, in Munich. The
euro crisis has highlighted the urgent need for reform in the Eurozone.
However, approaches to a solution can be divided into two camps. The disagreement,
primarily between France and Germany, is reflected very clearly in their
different attitudes towards fiscal union. While the French strongly support a
fiscal union, which necessarily implies fiscal transfers by Germany and other
donor countries, Germany absolutely rejects a fiscal union and favours a
post-crisis write-off of bad loans instead. In his speech Yanis Varoufakis argues
that both visions are flawed and potentially dangerous, going on to differentiate between the solution to the Eurozone’s structural problems and
the zeal and ambitions of its political class.

In these trying times for Europe, our common home,
opportunities like tonight’s to discuss honestly and frankly Europe’s crisis
are priceless.

When the title of my talk was announced, many of my
critics were puzzled. Having portrayed me as a Greek politician who, back in
2015, came to Germany cap-in-hand demanding more money, they had difficulty
explaining why I would be standing in front of you to argue that Germany
neither can nor should pay more to save the eurozone.

The puzzle of course disappears after a close look
at what I was saying since 2010. Let me give you an example. On July 24, 2013 I
published an article in Handelsblatt entitled ‘Europe needs a hegemonic
Germany’. In that article I had, again, surprised many by arguing in favour of
a strong Germany as the best way of leading Europe out of its difficulties. My
criticism of the German government, and its attitudes towards the eurozone more
broadly and Greece more specifically, was not that Berlin was not paying enough
but that, in a sense, it was paying too much – except that it was wasting the
German people’s money in perpetuating what I termed a gigantic exercise in
fraudulent bankruptcy concealment. Germany was
paying too much… in perpetuating a gigantic exercise at fraudulent bankruptcy
concealment.

I added that Europe needs a robust Germany, an
energised Germany, to lead the way, to use its money wisely – in other words to
be genuinely hegemonic, as opposed to spending too many resources on concealing
impossible bankruptcies. Indeed, back then, in 2013, I had warned that
continuing to insist on hiding serial bankruptcies would cost all of us more
and more and would require increasing degrees of authoritarianism to perpetuate
and reproduce the policies of denial.

In short, I wanted a Germany that was hegemonic and
efficient, not authoritarian and caught up in a European Ponzi scheme. That was
in 2013. Two years later, in March 2015, I wrote an article, while Greece’s
finance minister, referring to the first and second bailout loans, of 2010 and
2012. Allow me to quote from it:

“The fact is that Greece had no right to borrow from
German – or any other European – taxpayers at a time when its public debt was
unsustainable. Before Greece took on any loans, it should have initiated debt
restructuring and undergone a partial default on debt owed to its
private-sector creditors.

But this “radical” argument was largely ignored at
the time. Similarly, European citizens should have demanded that their
governments refuse even to consider transferring private losses to them. But
they failed to do so, and the transfer was effected soon after. The result was
the largest taxpayer-backed loan in history, provided on the condition that
Greece pursue such strict austerity that its citizens have lost one-quarter of
their incomes, making it impossible to repay private or public debts.

The ensueing – and ongoing – humanitarian crisis has
been tragic... Animosity among Europeans is at an all-time high, with Greeks
and Germans, in particular, having descended to the point of moral
grandstanding, mutual finger-pointing, and open antagonism. This toxic blame
game benefits only Europe’s enemies.”

A personal note here, if you permit it: For me,
nothing hurt more than my unfair portrayal as an anti-Europeanist Greek politician
demanding more money from Germany, or arguing that Germany must pay more for Greece
and for Europe. In fact the reason I resigned the ministry is simple: I was
refusing to sign the third bailout, to take more of your money, because I was
convinced that, when you are bankrupt you have no right to borrow more. What
should we have done? Declare bankruptcy, suffer the pain together with the
lenders that should not have lent to the previous governments, reform the
country and move on. What happened instead?

Italy
and Greece

A few weeks after my resignation, Mrs Merkel, Mr
Tsipras and others agreed on another 85 billion euros loan to the Greek state.
On that day I rose in Greece’s Parliament to denounce this as another
extend-and-pretend loan – another mountain of money given to the bankrupt Greek
state in order to pretend for a few more years that it is repaying its debts –
and granted under conditions that guarantee that the Greek economy and our
society would continue to shrink, that the debt would not be repaid, and
that Europe would move on to repeat the same mistakes in Italy – a country
whose public debts and banking losses are just too large for Germany and other
countries to sustain via Greek-like bailout loans.

That is what I said in the summer of 2015. Today, I painfully
observe the realisation of those fears. Italy has fallen to the forces of
xenophobia and Europhobia that welcome the European Union’s breakup. How did
that happen? It happened because the failed policies first tried on Greece were
also implemented in Italy.

Just like Greece, Italy had been ruled for decades by
a corrupt oligarchy enriching itself from EU transfers and relying on a kind of
‘establishment-populism ’ that traded on the impossible promise that
everyone would become better off as long everyone pretended to adhere to the EU,
Maastricht & Fiscal Compact rules – rules that could not be adhered to even
if the government wanted to.

When this promise was proven false, and the doom
loop of bankrupt state and zombie banks caused per capita income to shrink and prospects
for most Italians to wither, the electorate voted for a new government
representing two opposing anti-establishment populisms(that of the
xenophobic Lega and of the Five Star movement). The crucial difference, ladies
and gentlemen, between this Italian government and the Greek one I served in is
that we were committed Europeanists – we did not want to leave
the euro even though we had, realistically, to consider a Grexit – especially
when constantly threatened with it by the creditors. The main movers behind the
new Italian government, however dream of being threatened with Italexit, a fact
that guarantees a clash of gigantic enormity with Berlin, Brussels and
Frankfurt.

A
badly designed monetary union

These developments, ladies and gentlemen, are not
the result of bad choices, of human frailty. They are the result of a badly
designed monetary union. Germany is simply not rich enough to support this
faulty architecture. The EU cannot, backed by Germany, extend and pretend Italy’s
2.6 trillion debt, as well as the losses of their zombie banks. At the very
same time, Italy will continue to stagnate within this faulty architecture
until some political event will cause its uncontrolled, very costly breakdown.
It is the fate of an unsustainable system not to be sustained. The longer it is
sustained by political stealth and authoritarianism, the more catastrophic its
collapse will be, when it comes.

What
should we do?

So, what should we do? What should Germany do? Some argue
that we need the German treasury, and the treasuries of other surplus
countries, to support the treasuries of the deficit countries. This is both
infeasible and undesirable. Infeasible because the fiscal surpluses of the
Germanies are dwarfed by the banking losses and debts of the Greeces and the
Italies. Then there are those who propose the liquidationist approach – let
public debt default if it must. While I sympathise with the logic, and I wish
we had followed that approach with Greece’s public debt, liquidationism is
inconsistent with the euro architecture: following such government bond
automatic restructuring, our weak banks that rely on these bonds for collateral
and repo operations will go under, demanding of the weakened states to
refinance them – which defeats the purpose of liquidating part of their debt.

Back to square one then: What should we do? I shall
be arguing that:

The current rules cannot be applied, even if we were
all desperate to apply them

Those who seek a fiscal union with the German federal
government footing the bill of other governments are wrong: the German
government cannot afford to finance the eurozone’s necessary reforms and,
indeed, it should not have to

Those who propose the liquidationist route – e.g.
that the ESM extends loans to states at the price of restructuring of their
debt – are also wrong, because they do not take into consideration the doom
loop binding together the insolvency of our states with the insolvency of our
banks (e.g. Italy’s)

Proposing a new Treaty as a solution to the
eurozone’s immediate problems only deepens the sense of pessimism in the heart
of those who, correctly, estimate that the current political climate makes New
Treaties impossible

In this eventuality, there are two courses of action
that we must consider: One is the controlled dismantling of the current
eurozone. The other is a simulation of a federation using existing
institutions and new policies based on a re-interpretation of the letter of the
charters and treaties.

So, let me
begin by explaining why the current rules cannot work within our asymmetrical
monetary union (MU). Sure, the Maastricht rules and the ECB charter could have
worked fine in a symmetrical MU, as long as governments wanted/were forced to
stick to the rules: a symmetrical MU is one in which countries differ on productivity and
endowments but every market in every country comprises exclusively pricetaking
firms, customers and workers (in other words, no one has the capacity to
influence prices). In such a symmetrical, perfectively competitive union trade
surpluses and deficits, as well as different productivity growth paths, are
auto-corrected through a process of devaluation in the country whose
productivity growth lags behind and of internal revaluation in the ‘stronger’
country. Whether this devaluation is external or internal makes no difference.
Whether we have the euro or separate currencies does not matter, except perhaps
that under the euro we would have enjoyed lower transaction costs.

However, things are very different in an asymmetrical
MU. In a positively asymmetrical MU like our eurozone, financial markets are
bound to destabilise our economy and cause a crisis that makes impossible the
implementation of our rules.

What exactly
is an asymmetrical MU? It is a monetary union between:

1. National economies that comprise large oligopolistic manufacturing
sectors, replete with economies of scale (as well as of economies of networks
and of scope), with production units operating at excess capacity (that
reflects their market power and their capacity to deter competitors), and
concentrating much economic activity on the production of capital goods; and

2. National economies where the capital goods sector is atrophic, where
production is much less capital intensive, and where economic rents are not due
to economies of scale but due to corrupt practices and socio-political
impediments to competition (e.g. restrictive practices, crony relations between
authorities and particular business interests).

When one
nation, or region, is more industrialised than another; when it produces most
of the high value added tradable goods while the other concentrates on low
yield, low value-added non-tradables; the asymmetry is entrenched. Think not
just Greece in relation to Germany. Think also East Germany in relation to West
Germany, Missouri in relation to neighbouring Texas, North England in relation
to the Greater London area – all cases of trade imbalances with impressive
staying power.

A freely
moving exchange rate, as that between Japan and Brazil, helps keep the
imbalances in check, at the expense of volatility. But when we fix the exchange
rate or, even more ambitiously, introduce a common currency, something else
happens: banks begin to magnify the surpluses and the deficits.

They
inflate the imbalances and make them more dangerous. Automatically. Without
asking voters or Parliaments. Without even the government of the land taking
notice. It is what I refer to as toxic debt and surplus recycling. By the
banks.

It is easy
to see how this happens: A German trade surplus over Greece generates a
transfer of euros from Greece to Germany. By definition! This is precisely what
was happening during the good ol’ times – before the crisis. Euros earned by
German companies in Greece, and elsewhere in the Periphery, amassed in the
Frankfurt banks. This money increased Germany’s money supply lowering the price
of money. And what is the price of money? The interest rate! This is why
interest rates in Germany were so low relative to other Eurozone member-states.
Suddenly, the Northern banks had a reason to lend their reserves back to the
Greeks, to the Irish, to the Spanish – to nations where the interest rate was
considerably higher as capital is always scarcer in a monetary union’s deficit
regions.

And so it
was that a tsunami of debt flowed from Frankfurt, from the Netherlands, from
Paris – to Athens, to Dublin, to Madrid, unconcerned by the prospect of a
drachma or lira devaluation, as we all share the euro, and lured by the fantasy
of riskless risk; a fantasy that had been sown in Wall Street where
financialisation reared its ugly head.

Crucially, the private capital inflows from a country like Germany to a
country like Greece, alter the structure of B’s economy. A large, inefficient
service sector develops in the Greece’s while periphery’s manufacturing wanes
under the inexorable pressure of the surplus countries exports. While
manufacturing wages collapse in absolute and per worker terms, the portion of
the wage bill that comes from this parasitic, import-and-debt financed sector
rises. And so does the corrupt oligarchy in the Periphery, house prices and a
false sense of wealth. To sum this
up in a vulgar but accurate manner, this is similar to buying a car from a
dealer who also provides you with a loan so that you can afford the car.
Vendor-finance, is the term used. Only in Europe we practised it at a
macroeconomic level. This is
similar to buying a car from a dealer who also provides you with a loan so that
you can afford the car.

Irresponsible borrowers and
irresponsible lenders

I think you
can see the problem? To maintain a nation’s trade surpluses within a monetary
union the banking system must pile up increasing debts upon the deficit
nations. Yes, the Greek state was an irresponsible borrower. But, ladies and
gentlemen, for every irresponsible borrower there corresponds an irresponsible
lender. Take Ireland or Spain. Their governments, unlike Greek ones, were not
irresponsible. But then the Irish and the Spanish private sectors ended up
taking up the extra debt that their government did not. Total debt in the
Periphery was the reflection of the surpluses of the Northern, surplus nations.

This is why
there is no profit to be had from thinking about debt or surplus in moral
terms. And this is why my message to my German friends is simple: before the
crash, we Greeks invested our loans and transfers unwisely. But you invested
your savings, your surpluses, unwisely.

Let’s take a dispassionate look at Germany’s current account: it is
large, persistent, and extraordinary in international and historical comparison
for a large country that is not focused on exporting raw materials. This means
that your savings are increasingly entrusted to the hands of foreigners who do
not have the capacity to look after them. Germany's net international
investment position is over 50% of GDP, after discounting past investments that
have lost about 15% of GDP worth in the crisis. Moreover, the German surpluses
are mostly due to the non-financial corporate sector, followed by government,
with only a modest contribution by households and financial corporations having
actually turned to a net borrowing position. So, it is not the demographics
that drive the CA surplus in this country. It is the euro’s architecture.

When σ>0 everywhere, and we push τ to zero, we are forced to a large trade surplus –
which pushes the euro up and strengthens… Trump.

Will σ not equilibrate in the periphery if wages and prices
fall? Will internal devaluation – austerity not do the trick? No, because
private and public debts and losses do not devalue – and investment is deterred
by this loop of doom, by this recycling of state and private bankruptcies. Even
in countries like Spain and Ireland, the growth we have been celebrating
recently is due to another unsustainable rise of private debt.

And this is where the rules become impossible and the EU's attempt to pretend that they still hold ridiculous.

An example
of Europe’s Ponzi schemes by which to pretend that the rules were adhered to:

For the full lecture including the last 20 minutes,
not on the wrong question, “How can we pretend that the rules still hold?’, but
“the right question” which is, ‘ What must we do to stop this crisis from
destroying us?’ – see the video above. In argument 5, Varoufakis outlines two
stark options, the controlled dismantling of the current Eurozone or a simulation
of a federation. ( Video 58 minutes in all).

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